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tv   [untitled]    April 24, 2012 10:30pm-11:00pm EDT

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sec staff, contacted cftc staff to inform us of capital charges. the cftc staff also consulted with cme, finera, and cbo, regarding the rationale for additional capital charges. commission staff consulted with domestic and foreign regulators during the period of october 24th, through october 31st, as well as in the critical hours leading up to the bankruptcy filing. at the direction of chairman gensler, commission staff continues to review customer fund protection provisions of the commodity exchange act and our commission regulation to identify possible improvements. while the staff has not yet pro posed amendments to the commission, it is expected that they will make recommendations in several areas. at a minimum, i believe that changes should be made to our part 30 rules so customer funds held for trading on foreign
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markets are set to the liquidity regulations. that more information be provided to customers regarding how their funds are held and invested. and that more frequent reporting be provided to regulators and that fcms internal controls for the handling of customer funds be strengthened. i understand the severe hardship that mf gloeblz bankruptcy caused for thousands of customers who have not yet been made hole. customers may have correctly understood risks associated with trading futures and optionsable. they never an miss patrioted thpatrioted -- anticipated their segregated accounts were at risk of suffering losses. short fall in customer fund was a shock to the market from which we have not yet recovered. i believe the commission can make improvements to our regulatory oversight, of fcms and dsros to help restore
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confidence in the futures market and i will help the commission and congress to implement the rules necessary to enhance our ability to protect market users and to foster open competitive and financially sound markets. thank you. thank you. mr. cook, please proceed. good morning. my name is robert cook. i am the director of the division of trading and markets of the securities and exchange commission. thank you for the opportunity to testify on behalf of the commission, concerning the lessons learned and policy implications of the collapse of mf global. the bankruptcy of mf global has resulted in serious hardship for many of its customers who have experienced significant delays and uncertainty with respect to ability to access their own assets. more broadly, the failure of mf global and the shortfall in customer assets. highlight the need for financial firms and for regulators to remain vigilant in ensuring
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customer assets are appropriately protected. sec rules are designed to protect customer property by prohibiting broker dealers from using customer funds and securities to support proprietary positions and expenses. broker dealers that hold securities or cash for customers must maintain physical possession or control over securities that customers have paid for in full and cannot use the securities to support the firm's business activities. further, when broker dealers extend credit to allow customers to buy securities on margin, the rules limit how much of the securities the broker deemer can pledge to finance that credit it extended to customers. the rules also protect cash held for customers or derived from customer securities. rishg the bro requiring the broker dealer to maintain a bank account, in an amount that exceeds net amounts owed customers. these funds cannot be invested
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in any instrument not guaranteed by full faith and credit of the u.s. government. together with applicable sec capital requirements, and protections under the securities investor fro teprotection act t to ensure if a broker dealer fails, customer securities and funds will be available to be returned to the customers. the preferred, preferred method of returning securities customer assets in a cipa liquidation is to transfer the assets to a broker dealer. on december 9, the bankruptcy court approved the initial sale and transfer of all skus myrcus accounts. it applied to approximately 318 accounts held for nonaffiliated securities customers. the trustee, since the transfer, nearly all former mf global customers have received 60% or more of their account value. 149 customers have received the
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entirety of their account balances. we understand the 194 customers include any one entitled to an advance with the claim, net equity up to 1.25 million. jen really the rules governing protection of customer funds and securities have worked reasonably well over time. but we are considering whether there are ways they can be strengthened. the clarification and strengthen offed its of broker dealers unclueding an auditor's examination of effectiveness of broker dealer controls relating to assets. continuing to work with self regulatory organizations where sros strengthen broker dealer financial responsibility requirements. for example unjune of last year, the sec approved a rule requiring the establishment of registration, qualification and examination and continuing education requirements for certain operations or back office personnel.
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including those who handle customer assets. this rule should help ensure that those responsible for these operations are fully versed in their legal on li investigations including those relating to segregation and protect, of customer assets. in february of this year, modernization task forcing, issued 15 wrerecommendations including statutory changes. the sec staff is evaluating these wreck men dax recommendat. the sec is also engaged in a number of efforts both domestic and international to share more and better data, qualitative asements assessments of firms and markets. some include up proved coordination with sros, more frequent meetings with certain sros with financial oversight responsibilities. thank you again for the opportunity to testify on this important subject. i look forward to answering any questions you may have.
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>> thank you. mr. ketchum, please proceed. >> members of the committee, thank you for the opportunity to testify today. my name is richard kechlt tyhum, chairman, ceo of the finra. when a firm like mf global fails there is always value in reviewing the events leading to the failure and examining where rules and processes might be improved. clearly, continued impact of mf global's failure on customers who cannot access their fund is of great concern. and every possible step should be taken to restore the accounts as quickly as possible. with respect to oversight of mf globals, financial and operational, finra shared oversight, and the chicago board operations exchange the designated examining authority. when finra its not for a broker deemer we work closely and routinely analyze the focused
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report filings and annual audited financial statements as part of our ongoing oversight of the firm. while that monitoring focuses on a broad range of issues it is particularly relevant to note our surveillance team, placed heightened focus on ex-pope sure to european sovereign debt. during april and may, we began surveying firms their positions in the instruments. in a review of mf global audited financial statements, may 31, last year, our staff raised question as but a footnote disclosure, regarding repo to maturity, rtm, portfolio. during discussions with the firm. finra learned a significant portion of the portfolio was cl class r collateralized. they're afforded sale treatment and therefore not recognized on the balance sheet. now with standing that accounting position, the firm remains subject to credit risk throughout the life of the repo.
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beginning in mid june. finra and cboe, had discussions regarding the proper treatment of the rtm portfolio. our view was that while recording the repos as sales consistent with gap should not be treated as such for purpose of the capital ruled and market and credit risk. as such we asserted capital needed to be reserved against the position. finra and cboe, had discussions with the sec about our concerns. the sec agreed that the firm should hold capital against positions. the firm fought this interpretation throughout the summer appealing to the sec before conseceding in late augu. mf global infused capital and made filings. and september 1 notified regulators of the deficiency and change in net capital treatment of the rtm portfolio. following this, finra added mf global to alert reporting, heightened monitoring process where by we require firms to
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provide information, net capital and reserve formula compew tagstags tags -- computations. as mg global's credit rating was cut. at the end of the week, finra was on site at the firm with the sec as the it became clear, mf global was unlikely to continue to be a viable stand alone business. our primary goal was to gain an understanding of the custodial locations for customer securities, and to work closely with potential acquirers in coach of avoiding liquidation. as has been wide lely reported, while finra believes financial securities rules of the sec combined with cipa provide a good structure for protecting customer funds. firm failures provide an important opportunity for review and analysis of where impro improvements may be warranted. finra's identified changes to better protect customers and
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their funds. through the process and in terms of coordination with regulatory counter parts. most recently finra and chicago mercantile exchange, established calls, so our staff can share information about firms that are broker dealers. in addition. we initiated a series of briefings on select firms for domestic and international reg lators of securities and futures. our next briefing will be unjune. we have expandped the list of regulators and sro ss. we continued ow work on rule making efforts aimed at enhancing surveillance. starting in october, finra firms must file financial and operational reports that capture granular detail about a firm's revenues and expenses. last week, finra's board approved an additional report that would inform the assessment of off balance, on capital, leverage and liquidity. finra shares your commitment to
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reviewing mg global collapse. we will review our rules and procedures and reach out to fellow regulators to identify areas where processes may be enhanced. thank you for the opportunity to share our views. i would be happy to answer any questions you have. >> thank you, mr. duffy. >> chairman johnson, members of the committee, thank you for the opportunity to testify, respecting lessons learned from the collapse of mf global. i testified respecting mf global's misuse of segregated customer funds and cmes efforts on behalf of customers. today i will summarize. our efforts and the industry to restore customer confidence. the short fall in customer segregated funds was limited to the funds under mf global's control. the customer funds held in segregation by cems clearinghouse to cover futures positions were complete. ability to transfer positions and of our customers was undone by a provision in the bankruptcy code, providing loss sharing
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among all customers. we believe that congress can health protect customers whose collateral is safe guarded at a clearinghouse. it can do that changing the bankruptcy code to permit clearinghouses to transfer fully collateralized customers to other clearing members despite a failure of the clearing member. the industry is united in its search for solutions that will restore confidence and regulated futures and derivatives markets. obviously changes in the bankruptcy code are not easy or quick. it is constructive to look at a wide range of actions that can be implemented without legislation. cm echltd group along with exchanges and national futures association has proposed four, forms of intensified reporting to avoid misuse of funds. future association on behalf of members, proposed enhanced reporting. cme group is implementing proposals which will include one mandatory daily reporting of segregation statements by all fcms. two, additional surprise reviews
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of customer segregated accounts. three, a requirement thament the fcms, ceo, cfo sign all payouts of customer segregated funds:plus immediate notification to cme and four, a bi monthly report reflecting how segregated funds are invested and where they are held. cme has challenged the industry and commission to consider whether solutions will better serve the interest of customers and the industry. in addition to the proposed amendment of the bankruptcy code, cmes working with the clearing members to find a structure that will protect their collateral against fellow customer and fraud risks. we are committed to finding the solution that will provide strong protection for the seg ra ga -- segregated funds. from a legal operational cost benefit. without destroying the industry business model. in addition to the regulatory initiatives we also recently
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launched cme, group. this fund is designed to protect family farmers, family ranchers and cooperatives in the event of smort falls and segregated funds. we hope these steps will give confident to u.s. markets after the action and failure of mf cloeb global. it should not serve as a roone to undermine, front line auditing and regulating by clearinghouses and exchanges. some critics suggest the current wreck latory cy regulatory system is compromised. there are no conflicts of interests in cmes duties to ctfc, customers, and shareholders. it requires that it diligently keep its markets fair and open by vigorously regulating all market participantses. federal law mandates a structure that eliminates conflicts of interest. the current regulatory model served the future undus trindus
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customers and the public. we look forward to enhancing customer protections and foster confidence in our markets. thank you for your time this afternoon. >> thank you. i would look ike to thank all oe witnesses for their testimony the as we begin questions i will ask the clerk to put five minutes on the clock. for each member. judge freeh, just to be clear. given that $1.6 billion of customers funds has yet to be recovered, due to mismanagement or possible illegal transfers, by mf global, can you commit to us today that your office will not be seeking bonuses for any former or current mf global employee?
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>> if insurance coverage had been in place for commodities accounts, how would that have impacted the transfer of client positions? are there fcms as well as the the claims distribution process for former customers of mf global? do you believe that congress should study and revisit the idea of the -- of extending to commodities accounts an insurance coverage similar to that provided for circuitous accounts under the securities investor protection act? yes. cipra proceedings, govern liquidation of broker dealers contain well established procedures for contemplating and facilitating transfers of
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accounts to other solvent broker dealers and provide mechanisms for the prompt payment of customer claims. all of this is greatly facilitated because there is -- the financial support unfortunate the cipa fund which -- has -- in the case of cipa several billion dollars of assets and ability to assess the industry for additional fund. those funds would -- assist if it were necessary to cover short falls to enable a trustee to accounts, to other solvent fcms, i think as mr. duffy was alluding to. there are problems here. under the statute you have to -- distribute equally on a pro rata basis. yes, i believe if you had a fund which would give you more flexibility as a trustee, you
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could more rapidly transfer tenets, and at least have that in your arsenal of things to move things along. >> commissioner, could you describe any legal actions or are there efforts the cftc has taken to recover the more than $700 million of u.s. customer funds being held in the uk? how its the work of the cftc in this area been quord nated with mr. gins efforts to protect u.s. customers subject to regulation 30.7. >> thank you, senator. the cftc does not have -- the authority to bring an action in the uk court proceeding. but we are, as we are in the united states, working very closely with his staff, the law firm that he has hired to
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represent the, the -- the bankruptcy in -- in the uk and in front of the english court, and we will continue to monitor all of the different actions that happen in that proceeding. >> mr. gins, do you have anything to add? >> just to confirm that we do confer frequently with the cftc about the strategy in the uk and the nature of the legal issues. equally, we have, to the extent we can, shared information with judge free regarding that proceeding. of course all of those funds in the uk are segregated assets that belong to the 30.7 customers of the broker feeler. >> mr. duffy, do you have any views on the f.i.e.
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recommendations offered last month to better protect segregated customer accounts? also, would it be valuable for sros in the cftc to receive daily electronic backup documentation on these accounts directly from exchanges, clearinghouses, and custodial banks in order to confirm that the self-reporting seg funds by fcms is accurate? >> let me take the latter first. as far as the daily reporting from the sro and the cftc to the exchanges. i am a big believer, senator, in realtime reporting so it's kind of hard to argue with that. the reality is what's the prac kilts of getting that done? even if we would have it on a realtime basis, if people were
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having multiple books or doing nefarious activities, it would still be very difficult to detect what happened in the mf global situation. so as much as i support realtime tieouts, i think there is a lot of information that still needs to go into that. as far as the fia's recommendations on the sign-offs and similar things they've proposed, yes, cma group is very supportive of the recommendations. >> i note that senator shelby has temporarily left the hearing to attend an appropriations hearing and he will be back. senator corker. >> thank you, mr. chairman. thank all of you for your testimony. i sit through most of these hearings day after day, it almost gives you a hearing to think of all the regulators involved in one entity. we created that, you all did, so i'm not criticizing that.
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it does seem there's a lot of silos and various areas each of you look at that don't overlap properly. what i'd like to do is ask mr. giddens and just free, what happened? what happened to the customer accounts? how did the money end up in places that it was not supposed to end up? we've talked about everything but that here today. >> our analysis of what happened and where the money went i think is substantially concluded. that's the first phase of the process. because of the liquidity crisis in the last week, something like $105 billion in cash went out of
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the firm to banks, depositories, some to commodities customers, some to securities customers, in what on the surface appear to be ordinary commercial transactions. a great deal of this was caused by customers leaving the firm and asking that their assets be transferred out of the firm. also, the firm has to scurry around to find additional collateral. additional collateral was required with respect to the repo to market transactions which went from something like $200 million to maybe $900 million additional collateral required. in these firms, cash is moved around from various accounts on a daily basis. and it is possible that mistakes
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are made and you say we have excess in one category, you can use it to move to another, and so much happening in one week and so many volumes of transactions, that's where we think what accounts for the mistakes. so we know -- we can trace where the cash and securities in the firm went. and that we've done. the second, more complex phase, which we're also aggressively pursuing, is to get as much of that back if we have an appropriate legal theory to do that, and we've done that. we've had some success to date and will continue to pursue that with a goal of getting back as much of the property as we can. >> let me ask you this question. we can't all get the picture of what happened, a lot of money was moving around quickly, the firm was in a desperate state.
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with all of that occurring, regardless of the umpteen million regulators that look at this, the fact is how do you keep that from -- how do you keep, at the end, money going out of a customer account inappropriately some other place? how can even a regulator at that instant keep that from happening? >> given the fact that so-called operational personnel can move funds, have the authority to do it, it's almost not possible to build a foolproof system which would -- the checks that you have were the reporting requirements and also the totaling-up on a daily basis of what the segregation requirements should be. if there are substantial mistakes in that, it permits someone to say, theoretically, i
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have an excess in the commodities funds, therefore i can transfer that to the securities accounts, or vice versa. we had an example shortly after i was appointed. i had a call from mf global itself saying, we have wrongly transferred $220 million from the securities accounts to the commodities accounts and we would like to reverse that. how that was done or who authorized it or whatever, we can't say. but clearly there were mistakes being made. and part of this -- as i say, the processes that most people don't realize is relatively low-level operational people at any given time have the authority to transfer hundreds of millions of dollars -- >> was there an investment committee? i mean, when you -- is there
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personal recourse to the executives when these kinds of things happen? i mean, is there a way to deal with them on a personal basis against their personal assets? and secondly, was there any kind of investment committee or internal controls that existed there to keep this kind of thing from happening wind the firm, and if not, are there other firms to your knowledge that have these same problems? >> on the personal liability, i think there are -- well, personal view and people working with me view is that there are discrepancies so that seniors and higher-ups who do not directly authorize the young vice president to move money are probably -- very difficult to suggest that they are personally liable. that's one of the reasons i suggested that we look at that
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and begin to consider saying, it's not enough when you're managing the firm, determining the investments and the overall strategy, if you in effect create the liquidity crisis, that you will bear some responsibility if there are shortfalls in customers' property. i think it's certainly -- >> and just -- i know i'm running out of time. i'm actually over. were there internal controls or investment committee, was there any discipline within the firm that kept one person from making a big bet in the company going haywi haywire? >> there was -- my understanding was there was a -- an investment committee, there were risk officers at the firm. there were examples of where recommendations were not taken by the risk officer and under perfectly legitimate corporate structures, senior officers
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